What the Storm Financial case told us about wholesale client eligibility

The decision of the Federal Court in the Storm Financial case (or, to be legally precise, the case of ASIC v Cassimatis (no.8) [2016] FCA 1023) considers a number of legal issues concerning the operation of financial services businesses.

One particular preliminary issue which arose in the case was whether particular Storm Financial clients were wholesale clients or retail clients, and the judgement provides guidance and clarification on several aspects of wholesale client eligibility.

The wholesale/retail client distinction

There are a number of eligibility tests for being a wholesale client.

In the Storm Financial case, only the “product value” test was of relevance.  That test provides, essentially, that a person will be a wholesale client if “the price for the provision of the financial product, or the value of the financial product to which the financial service relates” is greater than $500,000.

The wholesale client issues that arose in the case

Four wholesale client issues arose out of the case:

1. Is the relevant amount the amount advised on or the amount actually invested?  With some clients, the investment advised by Storm Financial exceeded $500,000, although the actual investment made was less than $500,000.  The Court held that the relevant time for assessing whether advice was provided to a client as a wholesale client was at the time when the advice was given.  As long as the amount advised on exceeded $500,000, the client was a wholesale client.

2. Can multiple pieces of advice be aggregated in determining the value of the investment?  The product value test does allow for some aggregation of investments as long as the aggregation relates to a “single point of time” (e.g. advice to invest in a portfolio of listed securities that exceed $500,000).  However, this concession does not apply where advice is given at more than one point of time.

3. Can joint investors be aggregated?  This issue arose because many of the Storm Financial clients were married couples who received joint advice and were advised to invest jointly.  The Court held that each joint investor must be tested for separately in this regard, even if they are a married couple.

4. Is the total amount of the joint investment the amount invested by each investor?  This is a slightly different issue to the previous one as some married couples were advised to make their investment as joint tenants.  This is a common method of holding family property (particularly the family home).  The legal effect of a joint tenancy is that, upon the death of one joint tenant, the full interest in the property passes to the survivor.

The Court held in this situation that joint tenancy ownership is ownership of the entirety of the investment by each joint owner.  While this might imply that each joint owner of an asset worth $500,000 will be a wholesale client, the Court held that the test was actually the amount paid or payable to acquire the asset rather than the amount that each joint tenant might ultimately become entitled to.  Unless there was evidence to the contrary, the Court would assume that there was an equal contribution from each joint holder.

What wider implications arise from the decision?

The clarifications provided by the Court in relation to the advice timing and multiple advice issues are welcome and provide additional comfort to advisers who are using the product value test to determine wholesale client eligibility.

However, the product value test is, in practice, typically used by issuers of wholesale products and not many clients are in a position to invest $500,000 at a single point in time.  Accordingly, advisers tend to prefer the ongoing certainty provided by obtaining accountant’s certificates under the “personal wealth” tests with the result that these clarifications may be of limited assistance from a practical perspective.

In relation to joint investments, the Court’s decision that an adviser cannot invoke wholesale client eligibility by aggregating investors makes sense from both a legal and consumer protection perspective.  Two vulnerable, individual investors in need of regulatory protection should not be able to be magically transformed into a single investor who can look after their own interests.

Further, it is instructive to apply this principle in the context of two common client circumstances:

1. The married couple.  It is now clear that there is no special married couple rule for wholesale client purposes.  Instead, each spouse needs to be assessed individually with the result that it would be prudent for an adviser to refrain from using the product value test for a jointly advised married couple unless the investment exceeded $1 million.

It is, however, interesting to note that the corresponding “accredited investor” tests in the United States do allow for the aggregation of the net worth and income of spouses.

2. Individual SMSF trustees.  Applying the wholesale client tests to an SMSF is a particularly difficult aspect of the eligibility rules.

Where an SMSF has individual trustees, then those individuals are the joint legal owners of the SMSF’s assets.  On the basis of the Storm Financial case, it could be argued that each trustee would need to be a wholesale client in their own right before the SMSF could be treated as a wholesale client – and that the SMSF would be a wholesale client if all trustees were wholesale clients in their own right.

However, joint trustees of a trust are generally regarded as a single entity in relation to the operation of the trust.  For example, in Sky v Body (1970) 92 WN (NSW) 934 Street J. held that:

“Inherent in the basic system of trusts is the principle that trustees must act unanimously.  They do not hold several offices – they hold a single, joint, inseparable office.”

On this basis, the SMSF trustees would be considered as a single entity and the wholesale client status of each individual trustee would not be relevant.

As a final comment, in 2011 the Government issued an Options Paper on the appropriateness of the distinction between wholesale and retail clients.  Nothing resulted from that Options Paper and the decision in the Storm Financial case suggests that it might be time that the issue was again looked into – especially since the $500,000 product value amount has not changed since 1991.

Would you like to know more?

Author: David Court (Partner)